4 points) Insurance and social policy. You have been hired by an insurance compa

Question

4 points) Insurance and social policy. You have been hired by an insurance company to help them launch a new product which would pay for long-term care in a nursing home for people at an average cost of $150,000/year. Among 90% of the population, there is a 1% chance of going into a nursing home in the next year but for 10% of the population, people with chronic conditions or over age 80, there is a 10% chance of going into a home. Assume that people live two years, the current year and the next, and you buy the policy this year and either use it or not next year.

a.(1 point) If you were able to sell this to the entire population, what is the fair market value of this policy? (That is to say, what is the expected value of the policy to the average person?) What is the fair market price if you marketed the policy exclusively to people with chronic conditions and those over age 80.

b.(1 point) Who would you expect would buy your policy if you offered it at the fair market price for the whole population? Will you be able to make profits offering it at this price to anyone who wants the policy?

c.(2 points) What alternative strategies could you offer the company to make profits selling long-term insurance market? Think about moral hazard and adverse selection and how these affect your markets. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of long-term care insurance at an efficient price?

Explanation / Answer

a. Average cost is $150000

So fair premium for entire population = $150000*.9*.01+150000*.1*.1 = $2850

So fair premium for people with chronic conditions and over 80 = $150000*.01 = $15000

b. If the policy is sold at $2850 then healthy people will resist buying this policy as they know they are healthy and there risk amount is $150000*.01 = $1500 which much less than the premium. Only sick people will buy this and so company will not be able to make any profits.

c. This is a problem of adverse selection. Insurance company should go for health checkups before covering and then load premium according to the health condition. No, markets with these problems will cause long-term issues for insurance companies.

Related Questions

Navigate

• Browse (All)
• Browse 4
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.